The current conventional wisdom ­– broadly echoed by the news media and the blogosphere – is that comprehensive, economy-wide CO2 cap-and-trade legislation is dead in the current U.S. Congress, and perhaps for the next several years.

Watch out for conventional wisdoms! They inevitably appear to be the collective judgment of numerous well-informed observers and sources, but frequently they are little more than the massive repetition of a few sample points of opinion across the echo-chamber of the professional news media and the blogosphere.

Keep in mind that the conventional wisdom as recently as June of 2009 had it that – with the Waxman-Markey bill having been passed triumphantly by the House of Representatives – Senate action would follow; the only question raised by many commentators was whether the final legislation could be sent to the President for his signature by the time of the Copenhagen climate talks in December. My, how the conventional wisdom has changed!

But over the past nine months, the politics have not fundamentally changed. In June of 2009, passage of meaningful climate legislation in the Senate was already unlikely, because of the terrible economic recession in which the country found itself, and – of even greater political salience ­– lingering high rates of unemployment. And with the lack of Republican support for the stimulus bill, the relatively small (partisan) margin by which the House passed Waxman-Markey, the then-upcoming challenges of health care and financial regulatory reform dominating the legislative calendar, and concerns voiced about climate legislation by moderate Senate Democrats, success in the Senate was always a long-shot.

What is the Likely Legislative Outcome?

In addition to ongoing consideration of an economy-wide cap-and-trade system, another possibility now receiving attention is a utility-only cap-and-trade system, which some members of the Congress inexplicably find more attractive than an economy-wide approach. The result of such a system would be much less accomplished (forget about the President’s “conditional commitment” under the Copenhagen Accord), and at much greater cost. This would be equivalent to taking the Northeast’s Regional Greenhouse Gas Initiative (RGGI) as a model for national action. Not a good idea.

Even more likely is that the Congress would develop a so-called energy-only bill, which would – to a large degree – consist of killing the one part of Waxman-Markey worth saving (the comprehensive CO2 cap-and-trade system), and moving forward with the worst parts of that legislation – the smorgasbord of regulatory initiatives. As I’ve written previously, those additional elements of the legislation are highly problematic. When implemented under the cap-and-trade umbrella, many of those conventional standards and subsidies would have no net greenhouse-gas-reducing benefits, would limit flexibility, and would thereby have the unintended consequence of driving up compliance costs. That’s the soft under‑belly of the House legislation.

Without the cap-and-trade umbrella, that same set of standards and subsidies will accomplish very little, and do so at exceedingly high cost. Take just one example that seems to be popular among politicians – “renewable portfolio standards” (RPS), requirements that all states or all electricity utilities derive some fixed share of their power, say 20%, from renewable sources. Note, for example, that such an approach does not distinguish between coal and natural gas, despite the dramatically different impacts these fuels have on CO2 emissions (and a host of other environmental outcomes). Furthermore, although an RPS may displace some new coal-fired generation with other types of generation, there is little, if any, effect on the operation of existing coal-fired power plants.

If those other, regulatory parts of the climate legislation are so ineffective and so costly, why are they so popular with politicians? The reason is simple. The costs are hidden. The government simply mandates that electric utilities or manufacturers take particular actions, employing the best technology available. Where’s the cost? Unlike a cap-and-trade system, there’s no analysis and debate about the cost of allowances (and the marginal abatement costs they represent); and unlike a carbon tax, there’s no analysis and no focus on the dollar amount of the tax and the aggregate cost. That is the unfortunate but fundamental political economy behind much of U.S. environmental policy since the first Earth Day in 1970.

The White House (and most member of Congress) recognize that this is an inappropriate way to address climate change, but they seem determined to go forward, claiming that this threat will force the hand of Congress to do something more sensible instead. Unfortunately, this is akin to my telling you that if you don’t do what I want, I will shoot myself in the foot – not a very credible or intelligent threat. What I am referring to is that costly Clean Air Act regulation of CO2 will play into the hands of right-wing opponents of climate action, creating a poster-child of excessive regulatory intervention that will bring about a backlash against sensible climate policies. EPA claims that there will be no such excessive regulatory actions, because it will exempt small sources through a so-called “tailoring rule.” But legal scholars have noted that the tailoring rule stands on questionable legal grounds and could be invalidated by the courts. In this regard, note that the first lawsuits to stop EPA from exempting small sources are coming from groups on the right, not the left.

Perhaps Senator Murkowski’s proposed joint resolution (H.J. Res. 66), introduced on January 21, 2010, disapproving (stopping) EPA’s regulatory action under the endangerment finding could save the Administration. The conventional wisdom is that Senator Murkowski’s resolution has no political future, but with a bi-partisan list of 40 co-sponsors, that’s a total of 41 votes (more than the current total of 40 “Yes” and “Probably Yes” votes in the Senate for serious climate legislation, according to Environment and Energy Daily). And remember that the disapproval resolution requires only 51, not 60 votes in the Senate, under the rules of the enabling statute, the Congressional Review Act of 1996 (signed by President Clinton, and part of the Republican “Contract with America”). Of course, House action, not to mention signature by President Obama, would also be required for the resolution to take effect. But a positive vote in the Senate will send a strong political message.

So Is There No Hope for Good Climate Policy?

Here is where it gets interesting, because as much as the current political environment in Washington may seem increasingly unreceptive to an economy-wide cap-and-trade system or some other meaningful and sensible climate policy, there is one promising approach that could actually benefit from the national political climate.

In these pages, I have expressed support for cap-and-trade mechanisms to address climate change, including the system embodied in the Waxman-Markey legislation that emerged from the House in June of last year. Although that approach is scientifically sound, economically sensible, and may still turn out to be politically acceptable, there’s a modified version of cap-and-trade that could be much more attractive in this era of rampant expressions of populism, coming both from the right (“no new taxes”) and the left (“bash the corporations”). Neither of those views, of course, is consistent with sound economic thinking on the environment, but it’s nevertheless possible to recognize their national appeal and build upon them.

This could be done with a simple upstream cap-and-trade system in which all of the needed allowances are sold (auctioned) – not given freely – to fossil-fuel producers and importers, and a very large share – say 75% – of the revenue is rebated directly to American households through monthly checks in a progressive scheme through which all individuals receive identical payments.

Such an approach could appeal to the populist sentiments that are increasingly dominating political discourse and judgments in this mid-term election year. Such a system – which would have direct and visible positive financial consequences (i.e., rebate checks larger than energy price increases) for 80% of American households – might not only not be difficult for politicians to support, but it might actually be difficult for politicians to oppose!

Importantly, even though this is a specific type of cap-and-trade design (which has been known, studied, and proposed for decades), for better political optics, it should be called something else. How about “cap-and-dividend?”

A CLEAR Answer?

What I’ve described bears a close resemblance to the “Carbon Limits and Energy for America’s Renewal (CLEAR) Act,” sponsored by Senators Maria Cantwell (D-Washington) and Susan Collins (R-Maine). So, the politics of their proposal looks appealing, and the substance of it looks promising – a simple upstream cap-and-trade system (called something else), with 100% of the allowances auctioned (with a “price collar” on allowance prices to reduce cost uncertainty), 75% of the revenue refunded to all legal U.S. residents, each month, on an equal per capita basis as non-taxable income, the other 25% of the revenue dedicated to specified purposes, including “transition assistance,” and some built-in measures of protection for particularly energy-intensive, trade-sensitive sectors (not unlike Waxman-Markey).

That’s the good news. The bad news, however, is that the proposal needs to be changed before it can promise to be not only politically attractive, but economically and environmentally sensible. In particular, as it is currently structured, only producers and importers of fossil fuels can buy the carbon allowances. In an up-stream system – an approach I have endorsed for years – it is producers and importers that are subject to compliance, that is, must eventually hold the allowances. That’s fine. But there is no sound reason to exclude other entities from participating in the auction markets; and doing so will greatly reduce market liquidity.

Furthermore, the Senators’ proposal says that holders of carbon allowances are actually prohibited from creating, selling, purchasing, or trading carbon derivatives, thereby tremendously reducing the efficiency of the market and needlessly driving up costs. While no doubt borne out of a well-intentioned desire to protect consumers (remembering the recent impacts of mortgage-backed securities on financial markets), the Senators’ approach is akin to responding to a tragic airplane crash by concluding that the best way to protect consumers from air disasters in the future is simply to ban flying.

Less important structurally, but most important environmentally, an analysis by the World Resources Institute (which I have not validated) indicates that the caps – as currently set – would not bring about emissions reductions by 2020 that would even come close to the President’s announced goal of 17% reductions (equivalent to the Waxman-Markey targets), as submitted by the United States under the Copenhagen Accord.

But these and other problems with the CLEAR proposal can – in principle – be addressed while maintaining its basic structure and political attraction.

An Economic Perspective

It is interesting to note that many – perhaps most – economists have long favored the variant of cap-and-trade whereby allowances are auctioned and the auction revenue is used to cut distortionary taxes (on capital and/or labor), thereby reducing the net social cost of the policy. Cap-and-Dividend moves in another direction. This system (which was introduced several years ago in the “Sky Trust” proposal) has some merits compared with the economist’s favorite approach of tax cuts, namely that the Cap-and-Dividend scheme addresses some of the distributional issues that would be raised by using the auction revenue to fund tax cuts (which could favor higher income households). On the other hand, it eliminates the efficiency (cost-effectiveness) gains associated with the tax-cut approach. In fact, Stanford’s Larry Goulder has estimated that the tax-and-dividend approach would cost 40% more than an approach of combining an auction of allowances with ideal income tax rate cuts. (By “ideal,” I mean focusing on tax cuts that would lead to the lowest net cost.)

In general, there are sound reasons to seek to compensate consumers for the energy price increases that will be brought about by a cap-and-trade system, or any meaningful climate change policy. But it is important not to insulate consumers from those price increases, as diluting the price signal reduces the effectiveness and drives up the cost of the overall policy. Thus, “compensation” as in Cap-and-Dividend is fine, but “insulation” is not.

The most politically salient question with the Waxman-Markey approach of freely allocating a significant portion of the allowances to the private sector is how to distribute (that is, who gets) those allowances which are freely allocated. In this regard, contrary to much of the hand-wringing in the press, the deal-making that took place in the House and may still take place in the Senate for shares of free allowances is an example of the useful and important mechanism through which a cap-and-trade system provides the means for a political constituency of support and action to be assembled without reducing the policy’s effectiveness or driving up its cost.

The ultimate political question seems to be whether there is greater (geographic and sectoral) political support for the Waxman-Markey (H.R. 2454) approach of substantial free allocations and targeted use of auction revenue, or if there is greater (populist) political support for the full auction combined with lump-sum rebate which characterizes the “cap-and-dividend” approach. Alas, the textbook economics preference — full auction combined with cuts of distortionary taxes — appears to be a political, if not academic, orphan.

13 Responses to Any Hope for Meaningful U.S. Climate Policy? You be the Judge.

Interesting column, though I want to report my disagreement with a couple of key points. I do agree that the announcements of the death of legislation are premature, although I am increasingly concerned that they are declining. But I don’t agree that EPA regulation has to be an economic disaster. I think there is room to craft some program elements that could be, if not as efficient as economy-wide cap and trade, more efficient and effective than what you describe in your piece.

Also, I can understand your thinking about the Cantwell/Collins bill, but I have to tell you I would be surprised if it could command 20 votes in the Senate. In Waxman Markey they took the pains to pay off the interests involved, which got he support of some industries, notably those in USCAP. Cantwell has nothing to offer them, so wins none of the Democratic votes that represent the key industries; and wins no Republican votes. Always remember,the Republican Party these days will say anything to its hard right populist wing, but in the end it will always sell them out to the interests of big business.

Personally, I am losing faith in the Kerry/Lieberman/Graham effort also, because (1) they don’t seem to know what they are doing; (2) they are accepting ideas like mandating nuclear, which guarantee that they will produce a product that is outrageously economically inefficient, and most of all, because Graham has shown no ability to deliver any other Republican Senators. I think sooner or later the Democrats are going to have to call the Republicans’ bluff on the filibuster, and make them start talking — preferably about a jobs bill — so that the press is focused and the Republicans are shown to the public as the party of obstruction. Not until this happens, I fear, will we see global warming legislation in this Congress. Which says nothing about the next — almost sure to be worse.

Rob, to be frank, I don’t understand why you are the least bit optimistic. If any “climate” bill comes out of this Senate, it will be the environmental equivalent of the current “health” bill – massive, economically crippling new subsidies to the usual suspects, zero action on the real work that needs to be done.

As you should know by now from the partially effective Clean Air act, giving the usual suspects any kind of free pass is a guarantee of failure. Forty years on, obsolete coal plants that slipped the net are still operating without effective emission controls, proof that corporations are about as rational as your typical eight year old. Anything short of a comprehensive auction or tax will accomplish nothing. I can quibble with you about whether partially comprehensive synthetic SOx and NOx markets were the best way to get the job done, or whether synthetic pricing (tax) is superior to synthetic supply (cap and whatever). But neither will happen for US-generated carbon anytime in the next decade.

Cap and dividend isn’t new. It’s not bad, since the goal of internalizing carbon costs is not to extract revenue, but to provide a price signal for the damage that carbon causes. Most adult people will take that money and spend it on something other than carbon. it will also never happen, because the political goal of any legislation that passes will have little to do with actually internalizing carbon costs, or actually reducing carbon emissions.

A rational policy fix is impossible, unless we fundamentally change the political equation. As someone who has spent most of their professional career believing that good policy is the answer, this is hard for me to accept. But here we are.

In the ’70s the Nation was only just starting to experience international competition. The leveraging of debt possible due to the US dollar fully becoming a fiat currency was yet waiting for the Reagan Presidency for systemic exploitation. The US still had a net savings rate. OPEC’s & the World Bank’s use of the US$ for sales/interest was a foundation that ensured hegemony for the US. Corporate conglomerates paid for a great deal of the Federal Budget. Dinks and yuppies were yet to make their economic presence known. Finances were regulated. Boomer demographics secured a social safety net for the two previous generations. Even so, it took 6 years for the US economy to adjust to the energy shock of the OPEC oil embargo.

Unless I misunderstand what you’ve posited, the position is one that is micro-economically rationalized within a macro-economic reality that has ended. To the degree this is so, the advocated policy constitutes little more than wishful thinking because its rationale is grounded in motivated reasoning. While such non-rational thinking/feeling still passes itself off as ‘hope’ these days, it does little to help society to act intelligently. This lack of rational inteligence is why, “given piously privileged homo sapiens’ sentience there is no sensible climate policy [that is] possible.”

Listening to Todd Stern’s presentation yesterday at the Center For American Progress, Andrew Light again referenced McKinsey’s analysis for justifying a trust in what constitutes this Administrations climate policy and its economic viability. I believe that study’s economic parameters were set at the end of 2006 and early 2007—a time that is very different from today; from the ’70s. An economic recovery for the US, in concert with an energy shift/shock inherent with placing a price on fossil carbon (from which the US dollar garners most of its value) both a much longer process than that which was gone through in the ‘70s, and is now a global matter over which we have limited say.

What I feel your proposal fails to factor in its argument are these threats and changes that have unfolded since the ‘70s: The US now has lots of international competition. Credit has been leverage to the point of collapse—a temporarily flash-frozen one. The savings rate is no longer negative, but hardly such that it provides a solid economic foundation on which to build; on which an economy can recover from the shock a change in the global reserve currency. Corporations pay for a lot less of the government’s costs—and now, thanks to the Supreme Court decision, own it overtly make a reverse of the trend highly unlikely. Dinks & yuppies have been replaced by over leveraged wannabes and a transnational super-elite. The deregulated financial sector is too big to fail. Boomer demographics portend an end to denial regarding deficit spending.

While my Tweet asserts that no ‘sensible’ climate policy is possible, such only applies to the current paradigm’s sensibilities. Have you considered the environmental merits of replacing a extra-Constitutional Federal Reserve Note with a Constitutional currency coined in carbon credit and how such a sustainable economy might be organized? I have not read any of your 8 books, but I can see that you are quite vested in finding what feels like hope amid the mess we have made of everything without having to give up our cultural trust in greed-centric economic thinking and its supporting belief in the varacity of Abrahm Maslow’s modeling for altruism and moral behavior. If we could think different (or more to the point, feel different) I believe such a change in the currency would systemically redress the challenges of climate change. It would also effect the transfer of technology and wealth to the global south that the morality undergirding the cap and trade concept initially intended. The title of several of your books suggest that you do not subscribe to this morality. If this is true, perhaps the reason is the rationale Maslow’s Hierarchy of Need hypothesis afforded members of the effete corps of impudent snobs who characterize themselves intellectuals . . . & in my case, attempts such in less than 140 characters. 😉

Did Goulder’s research consider the MU of money to poorer folks compared to wealthier folks? For example, you can’t cut income taxes to poor people too far, and for most of us, you can only cut payroll taxes, as we don’t pay federal income taxes.

However, a $400 check each month, so long as it doesn’t come with subsidies to carbon-intensive products, would go a long way toward my participation in less carbon intensive purchases. Many poor folks simply can not make the up-front costs to reduce their long-term carbon footprint or to conserve. Refrigerators, washers/dryers, and solar panels simply have too high upfront costs. However, if energy prices went up, but I also got four hundred bucks a month, I’d be able to pay for these things.

Wealthier people don’t have this entry-level problem (which is why everybody wants to be wealthy). So, cutting their taxes won’t necessarily have the same stimulus impact on total demand for many products.

1) Despite the proposed scheme’s stated benefit, the article perhaps ignores the influence of US energy industry lobby and the individual (lifestyle) preference on the law-makers. Overcoming this power cannot be explained merely by economics but requires to be achieved through collective conscience of the masses – manifested through electoral results consistently and convincingly (check out the recent EU parliamentary election results). Given the current priorities towards economic resurgence, lowering unemployment rate and healthcare reforms, climate policy could very well be kept under wraps.

2) That the EPA GHG directive would be enforced. This is again unlikely, even if Senator Murkowski’s proposed joint resolution fails.

3) I was wondering how the proposed upstream cap-and-‘dividend’ is different from a conventional upstream energy tax (prevalent in most countries) that is made revenue neutral to the end users (assuming that the national treasury is like a ‘control volume’). Given that the energy demand is not just a function of cost but also of household income, the pass-through effect of the price signal could be ‘drowned’ if incomes increase disproportionately.

At the end of the day, economics may not be a bottleneck at all but point 1 above definitely is.

About the Author

Robert N. Stavins is the Albert Pratt Professor of Business and Government, Director of the Harvard Environmental Economics Program, and Chairman of the Environment and Natural Resources Faculty Group.

Disclaimer

The views expressed are solely those of the author and do not imply endorsement by Harvard University, the Kennedy School of Government, or the Belfer Center for Science and International Affairs.
This blog is based in part on columns published by The Environmental Forum, published by the Environmental Law Institute.